Ezra Klein has a really excellent column on war costs in today’s Washington Post (Business section). His essential point is pretty much a central philosophy here on EconomistMom.com: if we behave as if there are no budget constraints (yet there really are underlying tradeoffs among scarce resources that we just choose to ignore), we’re almost certainly going to make poor choices where marginal benefits fall short of marginal (and true) costs.

Some of my favorite parts of what Ezra has to say (emphasis added):

[F]or more than a decade now, we’ve waged war as if it were free, keeping our wars off the budget and, rather than paying for them as they were fought, slapping them on the national credit card. Paying as you go, after all, is hard. It forces you to make decisions about competing priorities. When you don’t pay up front, those decisions become easy. And war should never be easy...

Honest budgeting serves a purpose beyond making sure revenue matches spending… The numbers on the page — and the trade-offs they demand — are as close to rational as the political process can get. That’s the point of them. By forcing us to make the tough decisions, they help us make good decisions…

The Obama administration has improved the process some, mostly by asking for war funding when the budget is submitted (although the funding itself is still classified as “emergency” spending, and so is not actually ruled by the budget process), including some funding in the budget and more tightly defining what can go into the emergency packages so they don’t simply become budgeting by other means for the Pentagon. But the wars are still charged to the credit card and the Pentagon is still protected from trade-offs.

Even some within the armed forces worry about the Defense Department getting used to this system. Adm. Mike Mullen, chairman of the Joint Chiefs of Staff, gave an unusually frank news conference in January. “The budget has basically doubled in the last decade,” he said. “And my own experience here is that in doubling, we’ve lost our ability to prioritize, to make hard decisions, to do tough analysis, to make trades.”

By its very nature, war poses difficulties for the budget process. For one thing, its costs are at least partly economic, but its benefits often are not. The fact that saving the lives of thousands of Libyans won’t reduce the deficit doesn’t mean it’s not a good thing to do. Moreover, budgeting is about planning, and war is hard to plan for. It often starts unexpectedly, and it frequently ends unpredictably. We don’t know how long a war will last, or if it is known, we might not want that information public. But difficult is not the same as unnecessary.

“The whole point of budgeting is to provide transparency,” [Harvard budget expert Linda] Bilmes says. “It’s the place where we see where our real priorities are.” By refusing to budget for war, our leaders aren’t saying that the safety and security of the United States is our top priority. They’re saying that they’re worried the conflict really isn’t our top priority and that if asked to pay for it, the American people would think other budget priorities more pressing. But those are choices we need to make. Because we spent trillions of dollars in Iraq, it couldn’t be spent on better ways to improve the strength and security of the United States. Refusing to make choices when it comes to war is, in itself, making a choice — and not a wise one.

The same point could be made with any other part of the federal budget that we currently give (and for a long time have given) a “pass” to when it comes to paying for it. If it makes sense that we ought to be evaluating whether the wars that preserve freedoms and save lives are worth their cost, then certainly we should have applied that test to the higher physician payments under Medicare or the extended Bush tax cuts–things that mostly “preserve” and “save” the after-tax incomes of higher-income households–a long, long time ago.

31 Responses to “Ezra Klein: Without Paying for Our Wars, How Do We Know They’re Worth It?”

These sorts of common sense insights have always been their for leftist to apply to a hundred items we purchase but don’t pay for — but leftists have no interest in serious thinking about paying your way. Actions speak volumes, selective attention to narrow topics ust reveals massive hypocricy. Klein can’t be taken seriously because he does no apply this logic anywhere but here.

As I read through the post I was thinking the same thing that Diane then pointed out (as did Notbuyingit and Steve, who seem to have missed that Diane made the point).

Leaving aside war spending being off-budget and just addressing Klein’s point that regardless of process, “the wars are still charged to the credit card”, yes, the same can be said about any spending, since we’re running deficits and money is fungible.

I think an interesting and productive approach to this general point is ask not only what is worth paying for, but what is worth paying for now vs. putting on the “credit card” and paying for later or over time (and I’m even leaving aside consideration of timing vis a vis the economic cycle).

It is potentially justifiable to borrow to spending today for investments that yield economic benefits (as well as revenue feedback effects) over a number of years (capital spending on infrastructure, education, etc.). On the other end I think would be current consumption like seniors benefits, which I assume couldn’t be justified in economic terms as investments (yes, I know some seniors are quite economically productive and if Medicare keeps them alive longer it could be a good investment in individual cases, but I mean in aggregate, and as an aside I think means-testing should be applied in most such cases anyway).

So the question is: where does Defense spending generally, and a given war in particular, fit along that spectrum as an economic investment?

I think an argument can be made often — I’d say even generally — that such spending is at least intended by the decision-makers (ultimately the president) as an investment:
1) in ensuring a world environment conducive to commerce over time (even the long term, not just for a given situation but by signalling a that the US and perhaps coalitions won’t tolerate some types of disruptions of order — establishing that enduring general policy as a deterrent), and
2) to ensure a stable/low cost of vital economic resources, most notably oil. (Remember the oddly frank comment by Sec of State Baker on the eve of the Gulf War — to extract Iraqi forces from Kuwait — that the rationale came down to US “jobs”)

Of course, borrowing to spend on anything raises the required ROI for it to be worthwhile, given interest expense, but I think we should consider the potential investment aspect when discussing what should be paid for now vs. later.

“The same point could be made with any other part of the federal budget that we currently give (and for a long time have given) a “pass” to when it comes to paying for it. If it makes sense that we ought to be evaluating whether the wars that preserve freedoms and save lives are worth their cost, then certainly we should have applied that test to the higher physician payments under Medicare or the extended Bush tax cuts–things that mostly “preserve” and “save” the after-tax incomes of higher-income households–a long, long time ago.”

Her examples as you see are all her pet bugaboos in the budget. Had she left it at the first sentence, it would be a much less biased perspective.

As to the point on defense, I’ll make the point you make correctly many times. It’s inappropriate to call a particular bucket of spending the part we are putting on the credit card. We are putting some portion of all of the spending on the credit card, not this program or that program.

Because a FY 2011 Budget was NOT negotiated and passed the Continuing Resolution (CR) path is bring the ‘negotiation’ part of the budget process to forefront. It has not occcurred.

The Republican majority (many newly elected) in the House (where spending legislation must begin) have with virtually NO detailed analysis or discussion forwarded funding legislation for the balance of FY 2011 that seems to meet its agenda - including the existence and funding of certain programs that are currently ongoing.

Not that these programs should not be reviewed, analyzed, and discussed. They and many others MUST BE reviewed, analyzed, and discussed.

But they need to be dealt with in the full budgetary process - and not to just meet what appears to meet a ‘political agenda’. It has been said that fully defunding Title X( I have heard) but certainly/specifically Planned Parenthood would increase healthcare costs by women not getting pap smears, mammograms, etc; and unsuccessful pregnancies will go up by the tens of thousand for the lack of prenatal care (note I am not addressing the issue of abortion at all here).

Yet the $billions in subsidies to farmers and to ‘big oil’ [Exxon Mobil = # 2; Chevron = #3; ConocoPhillips = #6 in Fortune 500] - and of course the DoD budget remain unchallenged and in place

SteveinCH is absolutely right here. Whether or not we run a deficit shouldn’t depend on whether the deficit is caused by a particular party’s spending priorities (or, inevitably. a combination of them). The deficit is still the deficit. Brooks rightly points out that “money is fungible”, but then seems to forget that concept completely when he raises his “spend now for the future” exception.

If our federal government were required to spend no more than it takes in, our spending and taxing priorities would immediately come into very sharp focus. If forced to choose among spending on foreign wars or Medicare or raising taxes, the choice might well be to eliminate the spending on foreign wars. Or, if the choice is between spending on Medicare or education or raising taxes, the choice might well be education or to raise taxes. The point is that these choices would be necessary if the budget has to be balanced, but they are not necessary if we are allowed to run deficits (until the system simply breaks down, of course). With respect to the last parenthetical point, I recommend you read Greg Mankiw’s piece in Sunday’s NYT.

When you start saying it’s ok to carve out exceptions for one’s preferred programs (or spending”now” that allegedly pays for itself in the long run) the required discipline will be immediately and severely compromised. Have we not learned anything from the past 50 years or so of federal budget mismanagement?

I usually agree quite a bit with Hennessey, but this disappointing post, which is a shade of Grover Norquist, demonstrates that focusing on spending priorities will get us nowhere fast on reducing the federal deficit. Hennessey points out that there should be two questions to ask when considering the federal budget (other than the size of the deficit). The first is basically our spending priorities (a la Klein and EconMom) and the second is whether we want to fund the spending from current or future taxes (a la Brooks).

This confirms what I’ve long thought to be the basic truth about budget deficits and American politics: reducing the deficit is not a priority for either party. The battle between the two big parties is, and during my entire life has been, over how income is distributed. It’s that simple and despite all the technical argument thrown up by our economic high priests, this is just a smokescreen for furthering one’s objectives on that central issue. For Democrats, income redistribution is a phrase that is more or less taboo but it is at the root of their taxing policy and views on the size and role of government. For Republicans, the opposite is true, even if they phrase it in terms of smaller government or the economic inefficiency of taxes. I don’t know how fervently Democrats or Republicans actually believe in what they preach, but the political reality is that their respective sermons are necessary to gain support from their historical power bases. It has nothing whatever to do with concern over deficits.

Steve: yes, of course the test of whether the marginal benefits exceed the marginal costs (those costs being the true marginal costs including costs of deficit financing) absolutely should apply to every single dollar of government spending and tax cuts.

I took the first part of Diane’s statement at face value, referring to any part of the budget (any spending and also any choice of lower taxation), perhaps with a focus on those that are not part of the regular budget process or otherwise escape similar scrutiny re: trade-offs, rather than referring just to her examples and any other policies she may oppose. I can see how you could interpret it as you did, but per Diane’s comment above, she apparently concurs with what you and I have said: money is fungible so amid deficits anything can be said to be deficit-financed, and the cost/benefit should consider factor in the cost of borrowing.

As just a note, theoretically it shouldn’t even matter much if we’re talking about policy decisions “at the margin” in the sense of new (incremental) spending or a new tax cut (because any spending can be cut or any tax increased, making everything, in effect, at the margin until someone takes some of it as a given) but practically-speaking, decisions “at the margin” in that sense of “new” probably deserve a bit more scrutiny given the real-world “stickiness” of current policy. The policy choice at hand (and its impact on the deficit) is usually better known; the ability to agree on some other set of policy changes in other areas is much less certain).

Re: Brooks rightly points out that “money is fungible”, but then seems to forget that concept completely when he raises his “spend now for the future” exception.

I think you are misunderstanding me. “Money is fungible” means that amid deficits one can’t point to a particular area of spending as deficit-financed but not say the same about any another area of spending. My point re: deficit-financing relates to investment quality of a particular spending choice even given that deficits would be higher with that spending than without it (and therefore will add to related costs and will shift financing to taxpayers in future years).

See my note above to Steve re: decisions at the margin, and note that I’m speaking of an isolated “go”/”no go” decision on some policy that will increase the deficit (e.g., going to war or spending more on education) – in other words, take it or leave it for that particular policy, not trying to reach agreement to cut spending elsewhere to net it out. In an ideal, theoretical world similar scrutiny would be applied individually to everything in the budget — “Should we cut here to reduce the deficit, or is this spending a good investment even if we have to borrow to pay for it?” – but in practical reality the choice is often more constrained and dichotomous, and our immediate task is to apply ask that “investment” question to the policy decision at hand (e.g., worth going to war, increased spending on infrastructure or education, etc.), because if it passes the “investment” test, we should do it, and then seek to apply as much as possible that same question and additional tests* to other fiscal policy choices. (* “Is it worth making taxpayers pay for?” “Is it more or less important than something else?”)

I checked out Hennessey’s post. Not really my point. Hennessey’s point is (1) that we shouldn’t only focus on the size of the deficit, but also on spending level, and (2) that a higher deficit at a lower spending level may be preferable to vice versa. He contrasts a higher-spending balanced budget vs. a lower-spending budget with a deficit. He points out that some may consider the higher spending justified, but the point of the comparison is apparently that some may not consider it justified, and they would place enough importance on the lower spending that they’d prefer it even if it were accompanied by a deficit.

My point is that some types of spending yields economic benefits over future years and is therefore a good investment even if deficit-financed (possibly particularly if deficit-financed). And Defense spending in general and at least some military actions probably fall somewhere on that “investment quality” spectrum between spending on seniors (at the low end) and spending on infrastructure and education (presuming sufficient cost-effectiveness, of course) at the high end.

Re: If our federal government were required to spend no more than it takes in, our spending and taxing priorities would immediately come into very sharp focus.

True, but that doesn’t mean it’s a good idea. You wouldn’t suggest that as a general rule for businesses, would you? Obviously it is often smart for a business to debt-finance capital spending (plant & equipment, etc.) because it’s a good investment despite the interest expense (i.e, future cash flows from operations that the investment enables will yield sufficient ROI).

That said, although I give some consideration to the Keynesian argument that the economy is too weak for a balanced budget now, I think we should get much closer to a balanced budget as soon as possible given the projected long-term fiscal imbalance and the powerful driving forces behind it (retiring baby boomers and healthcare inflation).

Note though that the key metric is (publicly-held) debt-to-GDP ratio, and given GDP growth over time, we don’t need balanced budgets to reduce and stabilize debt-to-GDP.

Apropos of my initial comment, Obama said in his address tonight (emphasis added):

There will be times, though, when our safety is not directly threatened, but our interests and values are. Sometimes, the course of history poses challenges that threaten our common humanity and common security - responding to natural disasters, for example; or preventing genocide and keeping the peace; ensuring regional security, and maintaining the flow of commerce.

I am afraid that you (and Diane) are placing far too much emphasis on theory rather than experience. On the theoretical level, I could certainly agree with you that if marginal benefits exceed marginal costs, we might make an exception and run a deficit. I’m sorry, but this is not how the real world, particularly the real world of US federal budgeting, works.

First, even for someone who is objectively honest in going about applying the necessary calculus, the ability to determine when marginal benefits exceeds marginal costs is woefully inadequate. In most cases, even honest efforts will probably fail.

Second, it is simply human nature and particularly the nature of our political system that these tests will not be applied objectively. I’m sure proponents of Medicare will argue that the marginal benefits of increased and universal coverage exceed the marginal costs. Krugman will certainly misrepresent the marginal benefits of government stimulus exceed marginal costs because his real goal is income redistribution. A serious problem here with respect to benefits and costs is in evaluating which time frame is appropriate. In reality, it’s always a very short time frame. Also, I wonder which means of determining “marginal benefit” you and Diane wish to apply? A strictly econonometric model or some sort of normative economic one? So, your idea is far too theoretical to be useful in this context. If our greatest economic minds can’t agree on marginal benefits and costs, how do you expect the general public via the poliltical process to apply this test in practice? On the taxing side, there might be some general agreement on the validity of the Laffer curve concept, but in practice, there is no agreement on when the marginal “benefits” of taxation in the sense of increased revenues exceed the marginal costs. So, as Thomas Mann rightly observed, “everything is politics” and the decision as to whether running deficits is worth the costs is always, at the end of the day, a political one. Your marginal benefit test gets us nowhere in closing our fiscal gap—it merely opens the door wider to more political discussion and disagreement.

You wrote (beginning by quoting me):

“Re: If our federal government were required to spend no more than it takes in, our spending and taxing priorities would immediately come into very sharp focus.

True, but that doesn’t mean it’s a good idea. You wouldn’t suggest that as a general rule for businesses, would you? Obviously it is often smart for a business to debt-finance capital spending (plant & equipment, etc.) because it’s a good investment despite the interest expense (i.e, future cash flows from operations that the investment enables will yield sufficient ROI).”

Two things here: First, no, I wouldn’t recommend this to business, “as a general rule”, nor do I think, “as a general rule”, businesses recommend it to themselves. Businesses would demand that before borrowing to finance investments, it be clearly shown by a strong burden of proof that the marginal benefits of the investment exceed the borrowing costs. This may work, albeit imperfectly, for business, but clearly government is not business. Business gets a tax write-off for debt expenses; governments don’t.

More importantly, not only is the calculus for measuring marginal benefits and costs more straightforward for business, the constituency as well as the decision-making and governance structures are entirely different. Businesses generally have one constituency, their shareholders, and one objective, economic profit. Their “profit and loss” statement isn’t nearly as complex as government’s. Business and government are two entirely different creatures with entirely different objectives. Without having the discipline imposed by a required balanced budget, government simply is unable to make and enforce the difficult decisions required, much less apply the highly theoretical and naive notion that it is able to restrain its deficit spending only to those situations in which “marginal benefits exceed marginal costs”.

Further to VD’s point, the other challenge is that, in government, there is no “marginal” investment. It’s why businesses use WACC for cash flows rather than the cost of debt.

In effect, you want to allow government to use cost of debt for financing purposes on marginal projects but each project uses some component of debt financing to the degree there is debt. What your suggested solution would lead to is putting the highest ROI projects on the “marginal project list” rather than looking at all of the projects.

No, there is nothing excessively theoretical, much less naïve, in what I’ve said. I’ll try to clear up what I think is confusion on your part.

First, I was discussing how we should make policy choices (including how we, as constituents, should determine what policies to support and advocate), in particular with regard to deciding on a particular spending program or tax cut amid deficits (applying the “investment quality” test to see if it’s worthwhile even though, like everything else, it adds to the deficit; as a note I’d amend what I said before to say that doing it still might not be economically optimal, but I don’t want to explain because you’re mixed up on enough already and I don’t want to layer on something else).

Your response seems to be (1) that decisions are made largely on a political basis rather than a rational basis, and (2) it’s really hard to make the calculations to make decisions on a rational basis anyway. Both are true. Neither diminishes my point.

Stepping away from this meta discussion and going back to my point, I’m saying that there are some things worth doing even if partly/completely debt-financed rather than paid for in full immediately. And as I’ve said, in the real political world we often are, at least for the time being, stuck with some current fiscal policies and related spending levels and taxation (or close to those policies and levels), and we are stuck with some deficit, and in that case we are faced with an isolated yes/no decision to make on a particular policy that will add to the deficit, and to decide we should consider the timing of the economic benefits and the overall investment quality, particularly in terms of impact on GDP and revenue feedback effects.

To illustrate using the Laffer Curve you mentioned, if (just hypothetically) the overwhelming expert opinion were that a particular tax cut would actually increase revenues and GDP growth in future years to such an extent that the tax cut more than “paid for itself”, even after initial incremental interest expense from initially higher deficit, that would be a good investment worthy of incurring higher debt this year. (Only exception could be if there were even better investments at that point that would become bad investments after making the above investment, but that touches on that additional layer I’m leaving aside to avoid adding complexity).

Re: clearly government is not business. Business gets a tax write-off for debt expenses; governments don’t.

So? Not that I want to spend much time on this meta stuff, but what’s your point? Surely you don’t think that a tax write-off means something is free (do you?). There are obviously still required expenditures to service the debt (including interest) even net of the tax deductibility. Tax deductibility just means a lower effective interest rate, net of tax benefit, not zero interest rate, so I don’t see why you think that serves as a categorical distinction here.

Re: What your suggested solution would lead to is putting the highest ROI projects on the “marginal project list” rather than looking at all of the projects.

What makes you think that? What are you referring to as my “suggested solution” (just to check if there’s a misunderstanding there) and why would it have the result you assert?

Perhaps you are saying that if we go ahead with a new spending project or new tax cut because it seems to be a good economic investment despite adding to the deficit (i.e, despite the added interest expense, we’ll be “better off” economically* in the future if we make this investment than if we don’t), we’ll be less likely (politically) to “fund” those good investments by cutting other spending or continuing with lower tax rates elsewhere that do NOT pass that investment test (and which are not justified on non-economic grounds). That’s possible, but it doesn’t change the premise that we’d be better off going ahead with that new spending project or new tax cut than if we don’t. So the answer is not to reject it, perhaps unless one thinks he can win a game of chicken or successfully bluff that he’s willing to make the nation forgo a net-beneficial investment unless he gets other desirable fiscal policy changes. Unless that’s a viable and very effective negotiation strategy, there’s no sense throwing out a baby just because there’s bathwater around.

“First, I was discussing how we should make policy choices (including how we, as constituents, should determine what policies to support and advocate), in particular with regard to deciding on a particular spending program or tax cut amid deficits (applying the “investment quality” test to see if it’s worthwhile even though, like everything else, it adds to the deficit;…”

To be clear, again, I have no problem with the “theory” as you describe it; but, theory it is. How we *should* make policy decisions as constituents sounds like a pretty good definition of theory to me. And again, meaning no personal offense, I think it is naive. Your theory, though well intended, simply has not, and will not, work in the real world of American politics. Most Republicans will always argue that tax cuts, all tax cuts, pay for themselves; and most Democrats will argue that deficit financed stimulus, any stimulus, will pay for itself about 2.5 times over. And, unfortunately, the vast majority of “constituents” are not able to grasp your theory, valid is it may be, and even if they do understand it will inevitably vote in their own perceived short-term interest. That is the way it has been; that is why we are in the current mess we’re in; and that is the way it will always be until market forces dictate otherwise. Politicians and constituents have followed your theory, or at least their own version of it, all along. Wisely or not, decisions *have* been made on the basis that the perceived benefits of deficit spending today outweigh the future costs implied by government borrowing. One of the problems with your thinking is that you forget those who are making these decisions about borrowing and spending do so largely because of the current benefits accruing to them personally today; the future costs (it is hoped or at least implied) will fall on someone else or some future generation. It doesn’t work like that in business. The market generally ensures that future costs are discounted to present value.

Regarding the deductibility of interest for businesses, I raised the point, along with the others mentioned, simply to highlight the fact that your business analogy is imperfect, if not completely wrong, when it comes to budgeting. No, a tax subsidy doesn’t mean something is free, but it does mean something is subsidized. Perhaps this echoes somewhat Steve’s point, but the calculus for business making decisions on whether to fund investment through debt or equity (current taxation) is much more straightfoward than for government. Were it not for this subsidy, I doubt there would be much need or demand to fund investment via debt. Of course, government doesn’t get any subsidy for debt financing. To be clear, very little of what the government spends can be considered “investment”. And, with respect to that small bit, even if it could be measured, I really don’t think there is any economic benefit to financing such investment currently through taxation rather than through borrowing paid for future taxation. The only arguent to do so is when, as now, we’ve got ourselves in a mess by reckless budgeting. When you get right down to it, in the world of government, your “theory” is just used as an excuse to act irresponsibly.

“F]or more than a decade now, we’ve waged war as if it were free, keeping our wars off the budget and, rather than paying for them as they were fought, slapping them on the national credit card. Paying as you go, after all, is hard. It forces you to make decisions about competing priorities. When you don’t pay up front, those decisions become easy. And war should never be easy…”

I quite agree with that. Legitimate and necessary wars are one of the very few instances in which deficit spending might be appropriate. We should put them on the budget and think hard about the costs and the benefits involved, particularly the conflict such as the one in Libya. For me, Klein’s more significant point, though, is that without a legal requirement to put these costs on budget, this deliberation won’t happen. As far as war is concerned, his recommendation might be the only practical solution; however, an additional improvement might be to amend the War Powers Act to make deliberation and the consent of Congress more necessary and likely.

Per the Marron post, we’ve spent $600 million on the Libyan campaign in the first week alone. Afghanistan costs something like $140 billion per year and Iraq $40 billion. We’ve just heard a speech by President Obama, after that $600 million had already been spent, as to why our campaign in Libya is necessary. I hope that this is not what Brooks meant by evaluating marginal costs and benefits, but sadly this represents his theory in practice. I can imagine that the bulk of those costs was for spent muniitions, an industry that remains largely American, so I suppose this type of expenditure does much more to create American jobs that Cash for Clunkers. Perhaps this is a means of getting additional deficit stimulus spending approved before the next election in a manner that Republicans are not likely to object to. Paul Krugman should love this (as should, given his prior track record on stimulus spending, should Klein). Of course, you won’t hear them come out in public in favor, because the discussion for them and nearly everyone else has never been about the deficit, per say. And, that’s largely my point that every discussion about the deficit is really a smokescreen for some other aspect of one’s political agenda .

My problem with the original post, and the discussion that followed it, is that this same logic about forcing hard decisions for war costs has not been followed through consistently when we consider on-budget items. Brooks, in particular, has picked up on the theory that marginal costs and benefits need to be considered. Unfortunately, he seems to largely ignore the fact that without external (legal) constraints on deficits, this theory is pretty much useless. Of course, he’s right about the theory. But without legal constraints, such as constitutional or legislative limits on deficits, his theory isn’t even a bump in the road to even higher deficits.

And, with this type, and most other types of government spending, the business analogy just doesn’t go far. It’s pretty straightforward for Intel to do an analysis to justify the anticipated return on its investment for a new line of semiconductor chips or whatever, and to determine whether they would be better off to incur some debt to finance it. Some smart people will make some educated assumptions, crunch the numbers, and write a report and recommendation. A handful of people will make a decision, perhaps a hard one, and they will be held accountable in the relatively short term by the markets and their customers and shareholders.

Try making the same case for going to war, increasing Medicare or education spending, and whether to finance that through current taxes or increased government debt. Then, submit it to the Board which consists of several hundred members of Congress elected by nearly 300 million constituents. Sorry Brooks, but it just isn’t the same.

My point is that to force those hard decisions, legal constraints are necessary. PAYGO has not worked perfectly, or even very well, but I think that it has probably slowed deficit spending somewhat. Stronger PAYGO type rules would force more hard decisions than some theory of marginal costs and benefits, without more, ever will.

I think my argument is similar to Vivian’s. Yes, it’s true that some projects have a return that is greater than the cost of the project plus the interest costs. Having said that, we would either need to subject every project to a test at the weighted average ROI hurdle rate (as corporations do) or subject only some projects to a cost plus debt assessment as you describe.

There are fundamental practical issues with both approaches. The former approach is both difficult (since most government programs don’t have a definable outcome and no ROI assessment exist) and unlikely since it would shine a light on how much “waste” there is in government by that definition. There is literally no meaningful constituency in Washington that would support such an exercise and therefore it will not occur.

The latter approach (higher hurdle rate but only on some projects) is both impractical and, in my view, philosophically incorrect. It is impractical because one would have to agree on which projects should be so tested and, without the backdrop of testing all projects, the number would likely be very small. As such, it is far more likely that government actors would only serve up projects that pass the test as opposed to all projects that should have to pass the test which, as I said above, should be all projects.

Furthermore, it is not the case that only some projects should have to pass the debt hurdle. If you want to think about it, we are effectively doing some sort of modified NPV analysis in assessing programs, assigning additional cost to debt service in that construct. The problem is that all programs should be burdened with some portion of the incremental debt as opposed to labeling some programs as debt financed (and therefore subject to one hurdle rate) and others tax financed (and therefore subject to a lower hurdle rate). This is exactly why corporations use a WACC for all projects as opposed to assigning some projects different mixes of debt and equity financing.

In my experience (in manufacturing) investment depends first on whether the company believes there will be demand. Taxes, labor, transportation are all secondary. Taxes may well determine where new capacity is sited, but there must be (perceived) demand first.

This does not translate well to government “investment”. Basic education, infrastructure, and “defense” don’t have the cycles that consumer demand does. There will be more next year, so deficit funding them make little sense.

If the wars had been as short as Bush predicted, emergency spending might have seemed sensible, but past a couple of years, I don’t believe it. At this point a dedicated war tax would provide meaningful incentives to national discussion of our goals.

Retraining would be a good example of justifiable deficit spending as investment. When unemployment could be reduced by retraining, subsidizing it would be an investment in the economy.

Unemployment benefits are another example of justifiable deficit spending, but is it “investment” or is it “stimulus”.

Deficit spending to provide “entitlements” is also not investment and does not make sense. Yes, money is fungible, but creating a one-to-one correspendence between the revenue and the expenditure makes it far simpler to get people to decide whether they really want to spend their taxes that way. Driving home that the money they paid into Medicare will not pay for their medical expenses will help (if you can get them to listen).

Social Security is not the same. Currently, the money people paid in with the expectation that it would be paid out in benefits is enough. The adjustments needed to maintain that are not large. And mixing flat taxes paid on capped payroll with progressive taxes paid on all income is stretching the concept of fungibility beyond its breaking point.

You are still misunderstanding what I’m saying. I don’t want to spend much more time on this since we’re just going back and forth without making any progress, but I’ll try again and probably not much further if it doesn’t help.

Again, there’s nothing excessively theoretical or naive about what I’ve said; you are just taking it to mean other things.

I’m essentially presenting a common sense notion — that some things (particular spending or a particular tax cut) are worth incurring more short-term debt than we’d have without those things, and we should consider the ROI over time rather than opposing them on the basis that there are other things that do not pass that test (or other tests), which obviously also cause a higher deficit than we’d have without them, and which we’d like to get rid of.

So getting back to my initial comment, in the real world of politics and the budget process we are often faced with the question: “Should we do X (e.g., taking some military action, or spending more to maintain infrastructure, etc.) even though it means a higher deficit than we’d have without it?” And the answer is generally “yes” if it’s a very good economic investment.

In an ideal world would everything be subjected to that test (as well as non-economic tests)? Of course.

Will that happen in a thorough, competent, honest way by politicians and constituents? Of course not, although we should push for more of it, and we should advocate getting rid of stuff we consider unjustified, and advocate budget process changes that may encourage such discipline, including a stronger PAYGO despite its inherent limitations.

Does that “of course not” answer above change that “yes” answer above to “no” – meaning we should oppose what we believe to be good investment because we can’t achieve our ideal of getting rid of all the bad stuff at the same time? No.

Perhaps it will help you if I offer an even simpler illustration:

Suppose you think you are carrying too much debt and are runny a personal financial deficit this year already, but then you see an opportunity to borrow (at some normal interest rate) and spend another dollar today on something you are highly confident will yield $1,000 next year.

I’m saying that you should probably go ahead, because it’s a great investment despite the interest expense — you’ll be better off financially if you do it than if you don’t. And you should do so despite the fact that you spend on other things that don’t pass that “investment” test, and which, like all areas of spending, contribute to your deficit and debt this year.

Similarly, I’m saying we, as constituents, shouldn’t oppose what we consider excellent economic investments simply because we would like to lower the deficit this year or in the very short term.

You seem to be repeatedly saying that politicians and constituents either don’t apply such an “investment” standard honestly or don’t do it well or not at all. No kidding. What does that have to do with my point that we’d be better off making good investments than not doing so, so we as constituents should support generally support such policies to the extent we’re forced (in political reality, not theory, and not in your hypothetical world of strict, effective legal constraints on budgets) to choose yes or no? (see my note in comment to Steve about bluffing / playing chicken).

If someone proposed a tax cut today that you believed (on some sensible basis — let’s say on the basis of opinion expressed by the vast majority of prominent economists and other experts) was highly likely to much more than “pay for itself” by year 2 through incremental growth and revenue feedback effects, and then continue generating much higher revenues than we’d otherwise have in future years, would you oppose it because it increases the deficit in Year 1? I presume you would not oppose it. (again, see the “chicken” exception I noted). Does anything you’ve mistakenly said regarding my point supposedly being too theoretical or naive change your answer to “yes, I’d oppose it”? I presume not.

So you’re not really pointing out anything too theoretical or naive about my point, which again is just the common sense notion that we generally shouldn’t oppose making an excellent investment.

All you’re doing is making a separate point that the politicians and constituents won’t engage in an honest and competent assessment of ROI, and therefore we should force the politicians via “legal constraints” to balance budgets all the time and to make hard choices in doing so.

Of course, in a great many cases the factors considered and argued in making these choices will be related to ROI in some manner, so you haven’t escaped the problem you describe of ignorant, incompetent and/or dishonest politicians (and constituents) making false economic arguments. And based on what you’re saying we’d have no reason to suspect that the actual high ROI stuff would survive to a greater extent than other stuff as those hard choices are made. In that sense, when a good investment is proposed, an effective PAYGO (or some balanced budget requirement or whatever) is like that “game of chicken” – we’re better off making that investment even if we don’t offset it with reductions in undesirable spending (and/or tax increases), but the ideal is to get both, and PAYGO forces the choice of either getting both or forgoing a good investment.

That said, I have long been a strong advocate of the “process” side of this battle to mitigate our fiscal imbalance problem. I’ve long advocated various statutory restrictions (including stronger PAYGO, taking entitlements off auto-pilot, etc), however imperfect, because they could help highlight fiscal irresponsibility and thus raise the political cost (vs. the political benefit of handing out lolipops on the spending and tax sides).

As a note, though, lest you be — ahem — naive, don’t overestimate how much of a constraint such “legal constraints” really are. They are rules or laws that can be revoked by the same people they are intended to constrain (unless you’re also talking about a balanced budget amendment, which doesn’t seem likely to happen any time soon, if ever).

I guess my point is at a systemic level, I prefer a BBA to either statutory PAYGO or an exception for “high ROI” projects. Yes that means that some worthy projects will not funded but, on the whole, I would prefer that to giving politicians an out to spend on things that they shouldn’t.

I grant you that’s a judgment.

As to PAYGO, you know I’m opposed because it gives politicians cover without meaningfully changing outcomes…witness the current “stronger” PAYGO regime that is generating trillion dollar plus deficits. I’m a BBA or nothing sort of person. Show the naked emperor or put some real clothes on ; )

One more thing Brooks, I don’t think the notion that all respected economists are going to believe there’s a high ROI on anything in particular is all that likely. Should it happen, I might accept it but there are so many assumptions required in areas of policy, it’s unlikely. And so, once again, I fall on the side of restraining spending even though we may miss some opportunities.

I understand where you’re coming from. If we could manage to force lower deficits by some means, then depending on the mix of what spending was cut and what taxes raised (and to what extent), the gain from lower deficits via getting rid of undesirable stuff could be worth giving up some/many good investments.

I also understand your point re: PAYGO potentially having an adverse effect by providing political cover. On balance I think “strong” PAYGO statute and the practice of applying it are net positives, but YMMV.

I think that given the long odds against a balanced budget amendment anytime soon — and given that pursuit of it by politicians and candidates may be even worse than PAYGO in terms of politicians grabbing political cover rather than actually acting responsibly — it’s best for even its advocates (which I’m not, at least not yet) to support or oppose policies under the assumption that we aren’t going to get a balanced budget amendment, or for that matter a balanced budget by any means other than fortuitous economic growth.

Re: the “all respected economists” thing, that was for illustration to make the point. Regardless of how close to consensus, we still make judgments about level of risk vs. reward.

We can agree that applying a “return on investment” analysis to proposed spending might be a good thing, in theory. I’m certainly not saying don’t tr, so long as one doesn’t have unrealistic expectations as to what it might deliver. What I am saying is that over-reliance on this sort of thing has been and is folly. Frankly, it is what is already being done even if on an informal basis even though most things government spends money on are not susceptible to any rational ROI test and even if they were, that test would be abused. So, at the end of the day, I think we agree on that and also that if there is any effective means to limit deficit spending, it needs to be some sort of statutory or constitutional limitation. It is sort of like an alcoholic telling himself (or herself) that he won’t keep booze in the house lest he rationalize taking that one little drink.

Again, I think that stronger PAYGO rules or a balanced budget amendment, albeit imperfect, would be the most effective means of ensuring budgetary discipline. In this respect, I’m somewhat puzzled by the following statement you made in your comment to Steve:

“I also understand your point re: PAYGO potentially having an adverse effect by providing political cover.”

If you understand that point, you should understand mine. There is some truth to that statement, but here’s my point: Any ROI or similar test is going to be much much more susceptible to “providing political cover” than PAYGO ever has. What politician or constituent ever thinks that any spending proposal doesn’t deliver a good “return on investment”? That’s why I think reliance on such a concept, while perfectly acceptable in theory, might just do more harm than good in practice, or at least very little good. If formal emphasis on it is given in such a manner that would detract or draw attention from more practical solutions, it could very well detract from sound budget procedure. While, in respect of PAYGO, it is a “net positive” as you suggest, I am saying that any such “net postive” for a more formal ROI test would need to be diminished by a very large multiple, if not completely.

I’ve been back and forth with Brooks about PAYGO before and I know why he believes what he believes. I’m curious why you believe statutory PAYGO to be a net positive. If statutory PAYGO can produce $1.65 trillion deficits and the only time it has “worked” was in a surplus or near surplus environment, in what sense to you find it to be, on balance, good?

I can largely agree with what is said in that piece, but I would be less tolerant of allowing exceptions for short-term stimulus, etc, as Concord seems to be. As you may have gathered from my earlier posts, I am a firm believer in the “slippery slope”.

Make no mistake about it: PAYGO has had mixed results. I think it is realistic to expect to be able to improve it, but that same realism suggests it will never be perfect. To prove that without PAYGO our deficits would be higher, would require that I prove a counter-factual. Nevertheless, I think experience and common sense suggest it has worked somewhat, and can work better, if improved.

Critics of PAYGO usually note that Congress has, on occasion chosen to sidestep or ignore it, and on other, more frequent occasions, the rules have been gamed to exaggerate revenue or downplay spending. Also, some have argued that the PAYGO rules get in the way of effective tax policy.

There is, of course, some truth to these criticisms; however, when one thinks about it objectively, the criticisms simply boil down to the idea that PAYGO doesn’t work as well as it should. For instance, I don’t buy the idea that because PAYGO has been ignored in the past it means it is worthless. Quite the opposite. The fact that Republicans, for example, might ignore or override PAYGO to allow indefinite tax cuts, or Democrats to pass long-term entitlement increases, simply means that they view it as an obstacle that needs to be overcome. In my view, that hurdle needs to be higher. But, the fact that both parties have occasionally jumped over the hurdle simply means that it IS an obstacle. Common sense suggests, to me at least, that on some ocassions that hurdle wasn’t overcome.

I also think that historical deficits and the difficulties in overcoming them are largely a product of modern American culture, which emphasizes current consumption and gratification over longer-term considerations. This defect in culture carries over to the political arena and is exacerbated by our peculiar political system. I believe that most politicians, if they would not be punished at the polls, would be more inclined to “do the right thing” by passing more responsible budgets. But, neither party wants to take the lead, for obvious political reasons. This is clearly seen in the current environment where any serious discussion among politicians has to be held behind closed doors. So, a very real value of PAYGO is to subject both parties to the same rules of fiscal restraint which gives them a certain amount of “cover” vis-a-vis a largely ignorant electorate. Stricter PAYGO (as well as a BBA) could provide this needed cover.